As I wrote in my most recent blog entry, the JOBS Act (H. R. 3606), has been passed by both houses of Congress and sent to the President for signature. In that blog entry, I reviewed the final version of Title II of the JOBS Act (in a previous incarnation, the Access to Capital for Job Creators Act, H. R. 2940).
In this blog entry, I turn attention to Title III of the JOBS Act, which originated as H. R. 2930, the Entrepreneur Access to Capital Act, and was commonly referred to in the media as the CrowdFunding bill. That original version is summarized in a blog I wrote weeks ago.
But unlike the Access to Capital For Job Creators Act, which emerged in Title II of the JOBS Act in a form easily recognizable with its original creation in H. R. 2940 (albeit with the material changes I outlined in my most recent blog entry), the CrowdFunding provisions in the final JOBS Act are more than materially altered from the original House concept, they are rewritten SUBSTANTIALLY. Why? Technically, because the Senate wrote its own version of a crowdfunding act and substituted it for the House version, so when the House yesterday (March 27) passed the JOBS Act version that had won approval in the Senate last week, the House was really adopting the Senate version of "crowdfunding" in lieu of its own.
But to the bigger questions of "Why" and "What are the differences between the House view of crowdfunding and the Senate view of the same?", I am of the opinion that the SEC, in effect, won the contest in the Senate which it did not win (or didn't show up for) in the House.
Put directly, the CrowdFunding registration exemption favored by the House originally would have or could have really revolutionized small business capital fundraising: think gullywasher. The CrowdFunding registration exemption found in the JOBS Act has been captured by the SEC regulators: think drizzle.
As a result, I do not see at this time that Title II of the JOBS Act -- formally known as the"Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012" or "CROWDFUND Act" -- will amount to much. (Guess you can tell from the l-o-n-g name that the bureaucracy grabbed the reins of this legislation.)
To keep this entry about Title III of the JOBS Act shorter than a Joyce novel, I am going to be less detailed but more analytical than I was in discussing Title II of the JOBS Act, and enumerate the BIG changes from the groundbreaking original version the House passed way back in 2011:
1. Reread the act's title and you will immediately spot one big difference: capital raising "Online." Originally, the act would have permitted an issuer by itself OR with the help an intermediary to raise capital, and would not have restricted the fundraising means ("crowdfunding" and "internet" go together like car and driver, but the original act did not focus on the medium of fundraising but rather on the small size of each investment; if an issuer used the internet, great, but if it wanted also to use a seminar, or TV spot, or letter campaign, then have at it!). The Senate apparently believes that a small business is incapable of raising funds on its own without the assistance of a registered broker or registered advisor or registered expert of some sort -- pay particular attention to the word "registered" -- so the CROWDFUND Act doesn't permit an issuer to raise money by itself. Right up front, one of the conditions is that the transaction be "conducted through a broker or funding portal that complies with" the rest of the CROWDFUND Act. The issuer MUST use the services of an intermediary who must "register with the [SEC] as ... a broker ... or ... a funding portal [a new-fangled creation, discussed below]" AND "register with any applicable self-regulatory organization" like a national exchange or registered securities association (NYSE, FINRA, etc.).
So boom! A small business that wants to use the CROWDFUND Act exemption from registration MUST go through a registered broker [sounds like we've taken two steps back, and no steps forward] OR this new "funding portal" idea.
And the "funding portal" is where the internet comes in. The CROWDFUND Act amends the 1934 Act to identify what a "funding portal" is: a person that acts as an intermediary SOLELY for a crowdfunding offering AND acts like a neutral finder only (gives no investment advice or recommendations; just posts or displays offers to sale or buy securities, without soliciting purchases or sales; does not compensate anybody based on solicitation or sale of displayed securities; doesn't possess the securities or purchase money for securities; oh, and incidentally, doesn't "engage in such other activities of the [SEC], by rule, determines appropriate."). Watch out for that last condition!
So the Senate and the SEC have succeeded in deputizing brokers and others subject to its jurisdiction to police issuers that want to raise money through crowdfunding.
2. With that big shift enacted, I don't need to enumerate the statutory conditions imposed upon intermediaries and issuers for any crowdfunding offers. There is overlap with the conditions that H.R. 2930 proposed, but as you may expect, there are now more conditions and requirements to be policed by the SEC's deputies.
Example One: The intermediary -- broker or portal -- must take "measures to reduce the risk of fraud" that include "obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent" of an issuer's equity. All as further prescribed by SEC rules to be adopted.
Example Two: The intermediary is barred from compensating promoters, finders or lead generators who furnish the intermediary with identities of potential investors.
Example Three: The intermediary and its insiders cannot have a financial interest in the issuer.
Example Four: The issuer cannot "advertise" the terms of the offering but can only point potential investors in the direction of the broker or funding portal for information (a requirement which appears to conflict with the disclosure requirements elsewhere in the CROWDFUND Act).
3. To make sure that everyone knows this is an exemption from registration and not from the antifraud rules, the Senate (of course) added something else: ANTIFRAUD PROVISIONS. The CROWDFUND Act now includes a specific rescission/damages remedy for purchasers in the event of material misstatements or omissions, and potentially liable parties include the issuer, its directors and executive officers. These aren't exclusive, just in addition to the antifraud rules and remedies already existing under federal securities laws. Sarbanes-Oxley redux!
4. The SEC has nine months to promulgate regulations authorized by the CROWDFUND Act. Nine months to add to the statutory maze.
5. And now the toppers, if anyone needed one or two:
All this new regulation scheme, and an issuer can't raise up to $2 million per year through crowdfunding (in addition to funds raised through any other registration exemptions) as the original bill read; INSTEAD:
An issuer (TOGETHER WITH ALL OTHER ENTITIES IT CONTROLS OR IS CONTROLLED BY) is capped at $1 million per year through crowdfunding AND ALL OTHER OFFERINGS! So an issuer who elects to raise money through crowdfunding has blocked itself (and its parent and subsidiary entities) from raising over $1 million in any 12 month period. Period. AND:
Maybe, just maybe there is some wisdom shown on the other end -- the investment limits on purchasers? Naw. The original bill capped funding from any single investor at the lesser of $10 thousand and 10% of his annual income. The CROWDFUND Act? The greater of $2,000 or 5% of his annual income or net worth (provided EITHER net income or net worth is below $100 thousand); and 10% of his annual income or net worth (provided either net income or net worth is above $1o0 thousand) up to a maximum of $100,000. So an issuer can seek to raise $1 million in $2,000 increments from 500 small investors; or in $100,000 increments from ten big investors; or some combination of the two. Oh, yea: watch out that you don't become an "inadvertent investment company"; and have fun disseminating information to, holding meetings of, and conducting voting involving, a lot more owners than you probably want to have/ need to have.
Some other commentators, rushing out their analyses, have suggested that the CROWDFUND Act won't raise significant funds for small businesses or result in job growth.
They don't explain why, but reading the final version in detail, I regret to say they are probably spot on.
If Congress were subject to the truth and transparency duties they readily impose on citizens, they would have named this the "CROWDFUND Choking Act."